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Sunday, January 15, 2012

Students of SJMSoM, IIT Bombay today attended a workshop on ‘Interest Rate Risk Management’ conducted by Dr. S. Janakiramanan (SIM University, Singapore) and organised by Pearson Education, India. Dr. Janakiramanan is a well-known professor in the field of Finance.He started the talk with a comment on why even today there is minimal trading of Interest rate derivatives on the National Stock Exchange, India. He mentioned how during the recent financial crisis, implementation of the recent Basel recommendations caused volatile asset valuations for the American banks. As per recent Basel committee recommendations, banks in US are required to report their assets at their Market Value as opposed to the Indian banks who do so at book value. These are also the reasons why the US banks had to show major losses during the turbulent times of 2008-09 while the Indian banks didn’t.Moving further, he talked about the Interest rates in any country being the essential Marginal rate of substitution. This rate of substitution is best determined by the Loanable funds theory. Specific to the Indian context, Interest rates depend on 1. Real rate (If the economy does well, the rate is very low)2. Inflation3. Risk Premium4. RBI- this is dependent on various political issues.

Later he discussed about distress (downside risk) being both monetary and non-monetary whereas gain being the upside potential. Hedging can be used to reduce the downside risk involved with investments.He discussed at length about the various instruments used to hedge:1.Forward contracts (FRAs)2.Interest rate futures : a)Bond futures b)Eurodollar futures c)T-bill futures3.Interest rate options a)Caps b)Floors c)Collars

PS:1) In the Indian context, the regulations and recommendations were such that Bond futures and T-bill futures can be settled only with physical delivery.2) Caps and Floors are simply FRAs with options.Later on he discussed two cases relevant to the Indian context. These cases cleared many more concepts and helped understand the practical problems any given CFO faces while managing the Trade Finance and similar functions within the organisation.

As a conclusion to his talk, Dr. Janakiramanan gave the participants a background on the history of Interest Rate futures in India. The biggest impediment to successful implementation of these futures in India was the difficulty in understanding the ZCYC (Zero coupon yield curve). This seemed especiallyfunny since the ZCYC is that ‘Picture which speaks a thousand words’ when it comes to Fixed Income. Anyone who has cleared CFA Level 1 or FRM Level 1 examinations understands this curve in and out. But, as per Dr. Janakiramanan , the market participants had difficulty understanding the practical implications of the same. This led to the unsuccessful launch of Interest rate derivatives way back in 2003. He mentioned how, in 2009, new Interest rate Futures contracts were launched with following features:

10 year period7% couponsemi-annual coupon payments Underlying- Government of Indian BondsDelivery: PhysicalSettlement date: Last date of month.

He discussed the Orange county, California incidentat length and later on opened the floor for questions.The participants found the session really informative. Students of SJMSoM look forward to attending many more sessions and workshops in the fields of Derivatives- Credit, Interest rate, Risk, etc in the future!

Anoop Sherlekar

Master of ManagementBatch of 2011-2013SJMSoMhttp://www.linkedin.com/in/anoopvs

Some deem risk management as unimportant and totally a waste of time but it is actually an important factor in the business continuity management during the time that an organization is faced with an immediate threat.

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